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A 3 Fund Portfolio is a type of lazy portfolio that contains only three investments.
It’s called “lazy” because of how simple it is to set up and manage. Though, for once in your life, investing with a lazy portfolio is a situation where being lazy can pay off.
A 3 Fund Portfolio historically has a higher probability of providing a superior return to actively managed portfolios. This is because actively managed funds have a tendency to underperform the market, while a lazy portfolio simply attempts to match market returns while keeping costs low.
And as we know, a basic index investing approach that matches the market is a winning strategy over the long term.
The added beauty of the 3 Fund Portfolio is it’s simplicity – it’s easy to set up and manage. Anyone can do it on their own.
Disclaimer: Just Start Investing is not a certified financial advisor. This informational article on 3 Fund Portfolios and investing is designed to be educational, but not professional advice.
What is a 3 Fund Portfolio?
A 3 Fund Portfolio is exactly what it sounds like: an investment portfolio made up of three investment vehicles, or funds.
Specifically, the investment vehicles are:
- US Equity Index Fund (or ETF)
- International Equity Index Fund (or ETF)
- Bond Index Fund (or ETF)
The 3 Fund Portfolio was popularized by Bogleheads – loyal John Bogle (founder of Vanguard) followers.
John Bogle founded Vanguard and was a pioneer for index investors who valued low cost options. Before Bogle, it was nearly impossible for a small time investor to attain a diversified portfolio without paying large management fees.
The 3 Fund Strategy is actually so popular among index investors that a Boglehead (Taylor Larimore) even wrote a book on it.
Types of 3 Fund Portfolios: Choosing your Asset Allocation
The most effort you need to exert when setting up this lazy portfolio is deciding how much of your capital to allocate to each of the three funds.
This topic is hotly debated, but there are a few basic options to be aware of. Obviously, you are not limited to the three examples below, but they are a good start.
Equal Weight Asset Allocation
The first and simplest breakdown would be to assign an equal amount of capital to each fund in the portfolio.
80/20 Asset Allocation
Another popular option is to assign 80% of your funds to stocks and the remaining 20% to bonds.
The assumed split between US and international stocks here is 75% / 25%.
60/40 Asset Allocation
Last, the most conservative of the three examples is to assign only 60% of your funds to stocks and the remaining 40% to bonds.
Again, the assumed split between US and international stocks here is 75% / 25%.
Remember, the above are just examples to help you visualize how your portfolio could be split up. In reality, there are two really important things to decide on when choosing your own custom asset allocation:
- Allocation of stocks vs bonds
- Allocation of US vs international equity
We’ll dive into both below.
Stocks vs Bonds
There are two popular views on how much of your portfolio to invest in stocks vs bonds.
One view is that the percentage of your portfolio that you invest in bonds should match your age.
So, if you are 20, your portfolio should be 80% equities and 20% bonds. And if you are 60, your portfolio should be 40% equities and 60% bonds.
This is a good rule of thumb, but it is not necessarily the best approach.
Recently, many experts have recommended that you stay more aggressively invested in stocks later in your life. Warren Buffet has even suggested investing 90% in stocks (and only 10% in bonds) into retirement.
At the end of the day, you have to decide what risk profile is right for you based on how many years you plan to stay invested in the market.
US vs International Equity
Is 75% in US equities and 25% in international equities the right split?
That’s a tough question to answer. There are two popular opinions to understand on this matter as well.
One opinion is that even though US Equities are labeled as “US”, they still have a global element to them. Most US companies have parts of their business that operate and make sales overseas. So, by investing in US companies, you are also partially investing in international business.
Generally, supporters of this view believe you need a smaller percentage of money invested in international equities. Say, between 0-20%.
On the other hand, you have experts who believe you should market weight your stock portfolio to match the larger global economy. This would mean investing as much as 40% of your equity portfolio in international stocks because international companies make up around 40% of the global economy.
Vanguard recommends this 40% split, as they argue it provides proper diversification.
Likely, somewhere between 0-40% is the right allocation. There is no consensus here, so do a little homework and decide what is right for you. And if you can’t decide, you could take the same approach as Taylor Larimore and meet in the middle at 20%.
Benefits of 3 Fund Portfolios
There are a ton of benefits associated with 3 Fund Portfolios.
The list in this article does a good job of breaking down all the pros, but below are the three biggest benefits to be aware of.
The great thing about index funds and ETFs is that you can own hundreds, if not thousands, of stocks or bonds with only one investment.
With a 3 Fund Portfolio, you get the simplicity of only having to manage three investments while also getting the benefit of effectively owning hundreds of investments.
Having a simple portfolio makes it easier to rebalance, monitor and keep track of your investments. It also eliminates the need for you to pay someone to manage your investments for you, which is a huge cost you should avoid if you can.
The 3 Fund Portfolio also has low fees and expenses, when done right.
Most index funds and ETFs have expense ratios of 0.02%-0.10%, or less. This is a great value compared to an expensive mutual fund that might have a 0.25%-0.50% expense ratio. Or to a fund manager who may charge 1% or higher.
Plus, when you only need to buy three funds, it’s a lot easier to shop around and ensure you are getting the best deal on the three you choose. Rather than trying to find 10 or 20 funds that fit the low cost profile.
Last but not least on the list of benefits is the diversification that a 3 Fund Portfolio provides.
Yes, it’s only three funds. And yes, it was super easy to set up. But, as mentioned before, since your three funds are comprised of hundreds or thousands of stocks and bonds, you are easily and quickly diversified.
Diversification lowers your risk and helps provide steady, long term returns (on pace with how the overall market performs).
How to Build a 3 Fund Portfolio
Building a 3 Fund Portfolio is easy. At Just Start Investing, we invest with Charles Schwab.
Schwab is a great online broker for a few reasons, but mainly because of their low fees, wide index fund and ETF selection, and easy to use interface.
Of course, Vanguard is also a leader in this space. So we’ll walk through a couple example portfolios below to help you visualize how you can build your own 3 Fund Portfolio.
The following index funds would make up a Schwab 3 Fund Portfolio:
- SWTSX – Schwab Total Stock Market Index Fund (0.03% expense ratio)
- SWISX – Schwab International Index Fund (0.06% expense ratio)
- SWAGX – Schwab U.S. Aggregate Bond Index Fund (0.04% expense ratio)
Alternatively, Schwab also has some ETFs that have similar expense ratios as the above index funds. You could also consider:
- SCHB – Schwab U.S. Broad Market ETF (0.03% expense ratio)
- SCHF – Schwab International Equity ETF (0.06% expense ratio)
- SCHZ – Schwab U.S. Aggregate Bond ETF (0.04% expense ratio)
And last to call out on Schwab: they also have a S&P 500 Index Fund (SWPPX) with a 0.02% expense ratio. That’s a great value, but has slightly less diversification that some of the total and broad market funds above.
The following index funds would make up a Vanguard 3 Fund Portfolio:
- VTSAX – Vanguard Total Stock Market Index Fund (0.04% expense ratio)
- VTIAX – Vanguard Total International Stock Index Fund (0.11% expense ratio)
- VBTLX – Vanguard Total Bond Market Fund (0.05% expense ratio)
Vanguard, like Schwab, has a good selection of ETFs as well. You could also consider:
- VTI – Vanguard Total Stock Market ETF (0.04% expense ratio)
- VXUS – Vanguard Total International Stock ETF (0.09% expense ratio)
- BND – Vanguard Total Bond Market ETF (0.05% expense ratio)
As you can see, Charles Schwab generally has lower expense ratios across the board. Which is why Just Start Investing uses Schwab.
However, you can’t go wrong with either option. Especially considering that Vanguard was the pioneer of index investing and still has rock bottom fees compared to other investment brokers.
Another investment broker that can help create a lazy portfolio is Betterment. Check them out if you are looking for a really hands off approach. You can get my full guide on how to start investing with Betterment here.
3 Fund Portfolios – In Summary
One last great thing to note is the flexibility that comes with lazy portfolios. You can customize this strategy to meet your needs by going to a 4 or 5 fund portfolio, or a 2 fund portfolio (if you want to eliminate international equities all together).
Just remember the core benefits of a 3 Fund Portfolio and make sure you aren’t straying too far away for it’s intended purpose (a simple, diversified, and low cost portfolio).
And, to be transparent, while the 3 Fund Portfolio is an awesome strategy, it is not used at Just Start Investing.
While I admit, the 3 Fund Portfolio is likely superior to what I am doing, I created a slightly more complex portfolio early in my investing career which mimics the 3 Fund approach, but with a hint of equal weighting mixed in.
You can see info on how I set up my portfolio here.